6.13.00
We've Got Inflation Now

6.08.00
Rip It Apart

5.24.00
Give That Train a Green Signal!

5.24.00
Feeding Bill's Legacy

5.16.00
This Ain't the Free Market

4.28.00
Stop Knocking Dads

6/13/00 6: 55 p.m.
We've Got Inflation Now
The Fed's real problem.

By Gene Callahan, contributor to the Ludwig von Mises Institute

n a recent NRO commentary, Deroy Murdock faults Alan Greenspan for the fact that he "obsessively leads this immoral fight against illusory inflation." Murdock, critical of the Fed's attempt to slow the economy, berates the Fed for sacrificing the well-being of average Americans to "the imaginary gods of inflation." Murdock is correct in lamenting the disruption of people's lives by central planners. But Greenspan and friends began doing this four years ago when they began inflating, not last year when they began hiking rates. Or, more accurately, this particular form of disruption began with the creation of the Federal Reserve system.

The currently popular definition of inflation as a rise in prices is misleading, and serves to distract from the perennial cause of inflation — the government. Inflation is more properly defined as a large increase in the money supply. Inflation leads to an increase in prices, although it does not affect all prices at the same time. It may, for instance, first Affect the price of securities, so that we might suspect inflation at work when we see the price of a popular stock index soar from 2500 to 5000 within a few months.

When we look back to the root cause, we find that the Fed has been rapidly increasing the money supply. Economist Frank Shostak points out: "After falling to a yearly growth of 1.6% in May 1996 the yearly rate of growth in the money base climbed to 15.2% by December last year. Historically, the lag effect from changes in the money base to changes in the consumer price index is about two years."

The usual trope is that the Fed's job is to take away the punch bowl once the party gets going. Less known is the fact that it was the Fed that filled the punch bowl in the first place. Greenspan, having pixilated the economy, now knows he needs to pump us full of coffee before the drive home.

Murdock's catalog of "preventive measures" is flawed, due to this misunderstanding of the nature of inflation. For instance, Murdock says, "For now, only high oil prices seriously threaten price stability."

But a rise in the price of one commodity cannot "generate" inflation. If the price of oil rises without an increase in the money supply, the only possible results are a shift of spending from other goods to oil, or a decrease in the amount of oil used. After all, without more money available, how could consumers spend more than they previously did on oil and at least as much as they previously did on everything else? Similarly, Murdock warns us, "If rising wages outpace productivity growth, high inflation could indeed return."

It would indeed be more accurate to state that if this happens, inflation has long since returned. The economic analysis of the situation proceeds as above. The money to pay workers more must come from somewhere else! It's only when that "somewhere else" was the government's printing presses that we are in the midst of an inflation.

Murdock's last proposed solution is equally ineffective: "Finally, free trade curbs inflation by allowing the importation of low-cost goods and raw materials and opening markets to U.S. products."

While free trade has undoubted economic and geopolitical benefits, "curbing inflation" is not one of them. Imported goods must be paid for with exported goods or with cash. If the former, the goods leaving the country balance those entering, and the net effect on inflation is nil. The latter case is, in fact, a common effect of inflation, signaling that the citizens of the country with the trade deficit wish to lower their holdings of cash. Still, these dollars, to be useful, must eventually return to the U.S. to purchase something, raising the price of whatever those things are that foreigners eventually choose to buy. (In the last few years, we have good reasons to suspect that the "things" have been U.S. stocks and bonds, helping to explain the market surge.)

Giving the Fed the task of "fine-tuning" interest rates makes no more sense than having a central-planning authority set any other price in a market economy. However, it's useless to fault the Fed for taking away the punch bowl without also asking them to cease filling it in the first place.

Columns / Current Issue / Goldberg File / Nota Bene
Washington Bulletin / Subscribe / Ad Info / Home